My presentation on digital assets in bankruptcy - when blockchains meet bankruptcy - held on January 26, 2018, at Berlin Humboldt University, at the legal event "blockchain, law, blockchainlaw?" - https://www.rewi.hu-berlin.de/de/lf/ls/pls/conference-blockchain-law-blockchain

1. Digital Assets in Insolvency –
When Blockchains meet Bankruptcy

2. Purpose and Ideals of Bankruptcy/Insolvency Law
− No race to the courthouse
− Equal treatment of creditors
− Preserving value / assets
− Preserving employees and business
− Financial and operative restructuring and reorganization
− Fresh start
− Discharge of debt
− Difference between bankruptcy and insolvency law
Not: Punishment of debtor.
Economic failiure is not itself a crime. Only a learning experience
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3. What is a blockchain – at least for BaFin?
− Blockchains are tamper-proof distributed data structures in
which transactions are recorded in chronological order and
mapped in an understandable and unalterable form without
any centralised control.
− Blockchain technology makes it possible to save and manage
ownership more directly and efficiently than before because it
works on the basis of uninterrupted and unalterable data
recording.
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4. Risky Business - Ethereum
− Cryptography is an art, not a science. And the state of the art can advance
over time.
− Advances in code cracking, or technical advances such as the development
of quantum computers, could present risks to cryptocurrencies and the
Ethereum Platform, which could result in the theft or loss of ETH.
− The Ethereum Platform rests on open-source software, and there is a risk
that the Ethereum Stiftung or the Ethereum Team, or other third parties
not directly affiliated with the Stiftung Ethereum, may introduce
weaknesses or bugs into the core infrastructural elements of the
Ethereum Platform causing the system to lose ETH stored in one or more
User accounts or other accounts or lose sums of other valued tokens issued
on the Ethereum Platform.
− https://www.ethereum.org/agreement
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5. Bankruptcy vs. Blockchains I
−Challenge: Application of national, fragmented
insolvency law to transnational crypto-assets issues
−Multi-jurisdictional challenges
−They will not go way and you can only deal with
them as good as possible each time
−Obligation to file for bankruptcy, how would that
work for a DAO or another crypto fund or ICO etc?
−Automatic Stay – automatically violated?
−Ipso Facto Clauses / § 119 InsO
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6. Bankruptcy vs. Blockchains II
−How do you “find” digital assets?
−Just an issue of forensics / IT experts?
−Specifically, may an insolvency administrator sell off
found Bitcoins?
−Are there regulatory and AML issues for trustees and
insolvency administrators?
−Registration requirements?
− “tainted” assets?
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7. Smart Contracts – As defined by BaFin I
− Smart contract technology means the creation of programmable contracts
that are defined by program code and which are then automatically
implemented and executed in blockchains.
− At specific points in time, the smart contracts automatically check
conditions which are defined in advance. They can thus automatically
determine, for example, whether a transaction will be executed or
rescinded.
− For example, the engine of a car leased by smart contract might only start if
the leasing payment has been received. All this this would require is for the
blockchain to be queried.
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8. Smart Contracts – As defined by BaFin II
− Smart contracts also allow for faster settlement processes because tasks
are automated using software code. This means that business processes
can be simplified while human error, interface points and the transfer of
data between different media types are minimised.
− The risks associated with smart contracts primarily have to do with the lack
of a central entity which can take corrective action against any intentional
or unintentional misconduct.
− Ideal of “unstoppable” and “immutable”
− Question: Can law be unstoppable and immutable?
− Except for divine law, all law, be it statutory law or case law or law made
up by lawyers, is subject to constant change and usually does not last
long.
− Conflicts with the ideal that laws are meant to stabilize expectations and
society.
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9. Bankruptcy vs. Blockchains III
− How can loss of value be avoided if a smart contract does not
fit anymore but is immutable and unstoppable?
− Sorcerer’s apprentice dilemma:
− Ein verruchter Besen,
der nicht hören will!
− Herr, die Not ist groß!
Die ich rief, die Geister
werd ich nun nicht los.
− Digital Ruins?
− Are smart contracts programmed flexibly enough to cope with
new economic situations??
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10. Bankruptcy vs. Blockchains IV
− If smart contracts are "immutable and" unstoppable ", what
about the general ban on payments while insolvent, e.g.
according to sec. 64 GmbhG and the like?
− Example: automatic payment of damages by airline to
passenger for late flights, at the exact time of landing
− AirBerlin was flying while in preliminary insolvency
proceedings
− Would such automatic payments have been stoppable?
What if this was forgotten? Liability of management?
− What about avoidance actions / preference law suits?
− Intent is sometimes relevant - whose intent counts?
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11. Bankruptcy vs. Blockchains V
− German case law by the Federal Court of Justice:
"Für die Auslegung [von]Erklärungen ist aber nicht auf die automatisierte
Reaktion des Computersystems abzustellen […]. Nicht das Computersystem,
sondern die Person (oder das Unternehmen), die es als Kommunikationsmittel
nutzt, gibt die Erklärung ab oder ist Empfänger der abgegebenen Erklärung. Der
Inhalt der Erklärung ist mithin nicht danach zu bestimmen, wie sie das
automatisierte System voraussichtlich deuten und verarbeiten wird, sondern
danach, wie sie der menschliche Adressat nach Treu und Glauben und der
Verkehrssitte verstehen darf."
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12. Bankruptcy vs. Blockchains VI
− It does not depend on the view of the developer or the software:
"For the interpretation of declarations, however, it is not possible to rely
on the automated reaction of the computer system[...]. Not the computer
system, but the person (or company) that uses it as a means of
communication is issuing the declaration or is the recipient of the
declaration made. The content of the declaration is therefore not to be
determined in accordance with how it is expected to be interpreted and
processed by the automated system, but rather according to the way in
which the human addressee, in good faith and under accepted customsary
standards, may understand it.“
− Conforms to§133 BGB: When a declaration of intent is interpreted, it is
necessary to ascertain the true intention rather than adhering to the literal
meaning of the declaration.
− BGH, decision dated 16. 10. 2012 – X ZR 37/12 (flight booking)
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13. Bankruptcy vs. Blockchains VII
− Enforcement „against“ blockchains
− Unresolved – going after othher personal assets?
− Digitization of EU Company law via blockchains:
− Recent EU consultation
− Would solution be pliable enough for restructuring
scenario?
− Shares and shareholder votes registered on a blockchain?
− Encumbrance/Realization of assets?
− Automatic enforcment and disposal of encumbered shares?
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14. Bankruptcy and Blockchains
− Could this also be used by insolvency administrators or
debtors’ in possession?
− E. g. keep the creditor register on a blockchain? Why not?
− Insolvency plans / plans of reorganization as smart
contracts?
− As far as a blockchain-based company is involved,
with assets on a blockchain: should be considered
− Issue new tokens (or the like) to creditors willing to
participate in restructuring?
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15. What happens to the purpose and ideals of
Bankruptcy/Insolvency Law in blockchain land
− No race to the courthouse – is there even a courthouse?
− Equal treatment of creditors? Will code allow it?
− Pre-programmed preferences?
− Can they be broken up?
− Preserving value / assets? Digital Ruins?
− Preserving employees and business? Will code allow it?
− Financial and operative restructuring and reorganization
− Fresh start? If all is public?
− Discharge of debt? Possible under the smart contract‘s code?
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16. New paradigm of Bankruptcy/Insolvency Law in the Blockchain
World?
− Fresh start by receiving new digital identity?
− Clean slate?
− For corporations and natural persons?
− Asset deal conceivable?
− Instead of discharge of debt: providing newly created digital
funds?
− Other ideas?
− Do we need to rethink bankrupty and insolvency law in this
new space?
− Maybe a little bit?
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17. Outlook: Restructuring/Insolvency Law needs to be considered
uropean Parliament resolution of 26 May 2016 on virtual currencies (2016/2007(INI)) in which the EP:
otes that DLT’s potential to accelerate, decentralise, automate and standardise data-driven processes at
lower cost has the potential to alter fundamentally the way in which assets are transferred and records
are kept, with implications for both the private and the public sector, the latter being concerned in three
dimensions: as a service provider, as a supervisor and as a legislator;
oints out that clearing, settlement and other post-trade management processes currently cost the global
financial industry well in excess of EUR 50 billion per year, and that this and bank reconciliation processes are
areas where the use of DLT might turn out to be transformational in terms of efficiency, speed, and
resilience, but would also raise new regulatory challenges;
ighlights the fact that, in this regard, several initiatives have been put in place by private sector actors, and
invites competent authorities, at both European and national level, to monitor such initiatives;
urther notes that DLT could be used to increase data sharing, transparency and trust not only between
government and citizens, but also between private sector actors and clients;
ecognises the still unfolding potential of DLT well beyond the financial sector, including crypto-equity
crowdfunding, dispute mediation services, in particular in the financial and juridical sectors, and the
potential of smart contracts combined with digital signatures, applications allowing for heightened data
security and synergies with the development of the Internet of Things;
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